Gauging Guggenheim Insider Sentiment ETF's Performance

Academic studies have shown that stocks intensively purchased by insiders outperform index funds by more than 7% per year. Insider transactions are followed by several people and receive disproportional media coverage. However, there are not many funds that utilize insider transactions. Guggenheim is one of the few funds that capitalize on insider purchase data. Guggenheim has had an insider trading ETF (NYSEARCA:NFO) since late 2006 and this ETF has outperformed the broader market ETFs like SPY, IWM, and QQQQ.

We’re not in the business of promoting our competitors, but we are in the business of providing unbiased opinions about investing. The Guggenheim Insider Sentiment ETF is not a pure play on insider trading. It’s based on Sabrient’s Insider Sentiment Index. Sabrient developed a quantitative methodology that picks stocks based on insider buying trends and increases in Wall Street analysts’ earnings estimates (Zacks.com provides a ranking service based on revisions in analysts’ earnings estimates). Here is how Sabrient’s Insider Sentiment Index is constructed:

Potential Index constituents include all equities trading on major U.S. exchanges.

The Insider Sentiment Index is comprised of the 100 highest-ranking securities chosen from a subset of companies covered by more than one analyst.

Each company is ranked using a 100% quantitative rules-based methodology that includes composite scoring of a handful of specially-targeted factors, and is sorted from highest to lowest.

The 100 highest-ranking securities are chosen and given an equal weighting in the portfolio.

The constituent selection process and portfolio rebalance is repeated once per quarter.

We don't know much about earnings revisions. But we do know that stocks purchased by insiders perform spectacularly during the first month after the purchase. Sabrient’s methodology rebalances its portfolio quarterly, which means they’re 1.5 months late on the average. Guggenheim’s insider sentiment ETF doesn’t take advantage of the short term gains after the insider purchases. We don’t know what their exact methodology is, but this must be reducing their overall performance by 2-4 percentage points per year. Considering they’re an $80 Million fund, they leave $1.6-$3.2 million on the table every year.

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Despite this deficiency in their methodology, they’ve managed to beat the market since inception. We wonder whether they truly have alpha or if it’s because they potentially have a value tilt in their portfolio. Insiders are usually contrarian investors (i.e. value investors) and value investing historically outperforms market indices. We used Carhart’s four factor model to calculate Guggenheim Insider Sentiment ETF’s alpha (See how to calculate alpha and beta).

Since its inception in September 2006, NFO managed to beat the market by 50 basis points per month. This is wonderful for the fund’s investors but one should not confuse this with alpha. NFO has a monthly alpha of 22 basis points. This is slightly more than 2.5 percentage points per year. The fund has a small cap tilt with a regression coefficient of 0.53. Small cap stocks performed well during the past 4 years and NFO benefited from this. Unfortunately this doesn’t count towards alpha. Surprisingly, NFO does not have a value tilt. Since insiders generally invest in value stocks, NFO’s methodology successfully screened out these stocks. This must be due to their use of increases in analysts’ earnings’ estimates as a criteria.